How much wallet to allocate Bitcoin

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When people first get into bitcoin as a savings device, or when mainstream financial type people see it as a potential investment, they are quickly faced with the sizing problem. What proportion of my assets should I put into this promising new asset class?

For most maxis, this question is on the ridiculous side: naturally, as much as humanly (or cautiously) possible. The die-hard maxis are borrowing fiat to acquire more sats – the speculative attack of Pierre Rochard. If you hold any asset other than BTC, you are effectively shorting bitcoin; you don’t want to shorten bitcoin.

If we go back for a moment to the risk / diversification strategies of less convinced – and more risk averse – fund managers or common people, bitcoin is just a matter of careful sizing. If you can’t stand 100% and 0% is too low, what is a reasonable proportion?

Earlier this summer, Paul Tudor Jones described what he wanted with “bitcoin as portfolio diversification” – “The only thing I know for sure, I want 5% gold, 5% bitcoin, 5% % in cash, 5% in raw materials. “

Between 1% and 5% is a common allocation suggestion, even among “crypto-curious” people – mainly, I guess, because 5% is a nice and easy number (for example, few people will target an allocation of 7.648%). Other recommendations ranged from low single-digit percentages to over 10%. Single-digit grants are far from rare: even some top-tier university endowments seem to have something like this.

Of course, as things move quickly in this space, if you are targeting a proportion, you also need a rule for when to rebalance your portfolio and by how much. If you constantly rebalance your bitcoin holdings across other assets if and when the value of bitcoin rises, you are missing out on much of this potential benefit – and you could lose an unacceptable amount in taxes and trading fees. . This is usually good if all you are looking for is a little extra return on top of an otherwise traditional investment thesis, but quite disastrous if bitcoin does indeed repeat its tendency to multiply by 10 times its value. In those cases, your extra meager return will look like the people who bought cars or yachts for Bitcoin in 2013: woefully expensive.

Economists Yukun Liu and Aleh Tsyvinski of Yale and Rochester Universities respectively, concluded in a three-year article that bitcoin exposure of between 1% and 6% is the optimal size, depending on how high you project its futures. annual excess returns. (30, 50, 100 or 200% respectively). These numbers are now old and we have had large scale retail and institutional adoption since then which seems to have increased the correlation with the overall market. Presumably too, as I have argued elsewhere, the feedback profile must also drop. According to Liu and Tsyvinski, these two factors should reduce the optimal allocation of bitcoin to a wallet. William Baldwin of Forbes writes, correctly in my opinion, that

“… the history of bitcoin is short. It’s one thing to look back on a century of stock and bond history and draw conclusions about the return and volatility you might expect. is another to extrapolate anything from the scary first decade of a virtual object.

Bloomberg’s Joe Weisenthal frequently points out that bitcoin has become oddly correlated with other risky assets:

“One of Bitcoin’s main selling points is its diversification benefits, but these days it’s almost tick by tick just your standard risky asset. It could be a cloud stock or Tesla. Or heck, even gold.

And Amy Arnott for Morningstar, showing that BTC’s relationship with other assets is changing:

“As traditional investors increasingly embrace bitcoin, its value as a diversification tool is diminishing; therefore, there can be no assurance that adding bitcoin will improve a portfolio’s risk-adjusted returns, especially to the same extent as in the past.

Now bitcoin doesn’t actually trade on forward-looking inflation expectations, but is much more sensitive to real interest rates of which inflation is only a part – beyond specific events like fears. Chinese miners or Elon Musk’s tweets, anyway. Thus, it shares a relationship with gold, the main drawback of which as a financial asset is its opportunity cost in a high interest rate environment. If you don’t think it will come back, stacking sats is an investment choice with no opportunity cost.

The wise investment advice not to put all of your eggs in one basket has its version of academic finance in diversification. It doesn’t just mean owning shares in a few different companies, if all of those companies are exposed to the same risks or trade more or less identically to each other – and with central banks running their money printers, everything slowly becomes the same trade. The theoretical point of what is called modern portfolio theory is that different segments of your portfolio compensate for other segments, so that random shocks, good or bad, keep most of your nest egg intact, no matter what happens. You want uncorrelated (or negatively correlated) assets so that in case of emergencies or one-off events, you preserve your savings.

For a long-term investor, managing his own funds (or perhaps a household’s) and planning for decades, this may not be such a crucial thing. The advice for ordinary people to invest on average in passive or other mutual funds is precisely this: you will not use the funds in the next 5, 10 or 20 years, and therefore the value to you of having a more fluid portfolio trajectory makes less sense. What you want are returns over decades, that is, in practice until you retire. Even taking into account the incessant complaints from the financial media about price volatility seems to do very little on the financial record of this asset. Bitcoin’s Sharpe Ratio, that is, its returns relative to its volatility, consistently outperforms most other assets:

“Risk-adjusted returns are calculated using the Sharpe ratio over a 4-year HODL period”, courtesy of Willy Woo

That is, even ignoring its obscure beginnings, a few years of bitcoin’s HODLing more than enough paid off for its short-term price risks.

How do you make sense of all this?

It is important to remember that all of these rules are generic and may not be suitable for your financial situation. In all fairness, responsible wealth advisers could not give much more specific advice publicly in interviews read by millions of people – that is, talk about financial terms of which they know very little. Giving general statements of 2%, 5% or 10% of your savings is completely detached from three crucial elements of your life:

Timing: when are you going to use or do you need the funds? Are you retiring at 40? Or are you retiring at a more regular retirement age? Are you acquiring an immaculate asset with an infinite lifespan to pass on to your heirs Risk tolerance: How comfortable are you with seeing investments rise and fall in value over short periods of time or medium? If you can’t sleep at night due to fluctuations in the price of certain assets, this is a clear sign that you are overexposed. Some people are jaded about it, stacking intact up to 50% or more; others are nervous like scared cats. Evaluate your positions accordingly. Income security: Other financial commitments are important, such as “How much do you earn?” “” How much does your spouse earn? “” What are your expenses? Unless you are holding BTC as a Hail Mary bet against what seems like an overwhelming world (in which case I advise you to get your house in order first, metaphorically speaking), I would not advise not someone who has nothing in his name to buy bitcoin with their lunch, or their rent, money. Don’t max out your second credit card to invest heavily in bitcoin if that means your family or kids can’t eat.

These criteria will be different for all of us, as well as the knowledge and understanding of how bitcoin works, as well as how the existing monetary and financial system surrounds all of these criteria. In general, the deeper you go down the rabbit hole, the more convinced you are of bitcoin’s long-term price potential, and therefore the more comfortable you feel with a higher share of asset allocation.

The issue of attribution is much more complicated than a single number. Ultimately, you might not even think of BTC as part of the rest of your investment portfolio, but as a free-floating independent asset over which you have uninterrupted full ownership.

This is a guest article by Joakim Book. The opinions expressed are entirely theirs and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.

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